The term “spread”, as used in finance, refers to the bid-ask spread, also called the bid-offer spread. The spread is the difference in price between the lower bid price or the “buy” price of an asset, and the higher ask price or “sell” price of the same asset.
The bid price is the highest price which investors are willing to pay for assets. The ask price is the lowest price at which asset holders are willing to sell their assets.
As a rule, the ask price is higher than the bid price, which results in the bid-ask spread. The seller wants to earn the highest possible profit on the sale of their assets, while the potential buyer aims to spend the lowest possible amount to procure the assets. If a security is sold immediately after it was bought, the trader will normally make a loss equal to the bid-ask spread.
Wide spreads can hint at an illiquid market or high market volatility. The more frequently an asset is traded, the smaller the difference (the spread) between the bid and ask prices will be. Stocks issued by large companies generally have much smaller spreads than those of smaller companies, because they are traded more frequently.
In forex trading, the spread is the main cost which currency traders pay to online brokers or banks. The wider the spread, the more the broker earns on the transaction.
Example: You want to exchange Swiss francs for euro, or in other words, buy euros with francs. A dealer offers you 0.910 euros per franc. So 100 francs would buy you 91 euros. If you were to change that 91 euros back into francs at the same dealer, you would only receive 99 francs for your 91 euros. The 1-franc difference – the spread – is taken by the dealer. In this example, the spread is 1%.
But spread “fees” are not only present in forex trading. Many financial services providers includes currency exchange spreads as hidden costs in their financial services, and customers are often unaware of these costs.
For example, credit card issuers earn money on foreign currency exchange rates every time cardholders use their card to pay at foreign merchants. Most cardholders are not aware that they are paying these extra costs.
Foreign currency exchange fees – or spreads – also represent a major source of revenue for many other financial services providers and affect checking account transactions, foreign currency withdrawals made using a debit card, wealth management, stock trading and private banking.
More on this topic:
Online trading: interactive comparison
Forex trading in Switzerland
What is an ask price?
